Policy and Uncertainty: 3Q in Review

Influential factors over the next six to 12 months include trade policy, interest rates and economic growth.

Each quarter, the Raymond James Investment Strategy Committee completes a detailed survey sharing their views on the investment environment, and their responses are the basis for a discussion of key themes and investment implications covered in this quarter’s Investment Strategy Quarterly. Read an overview of the key themes below, or download the entire publication for a more thorough view of the markets and the economy.

U.S. Economy

“Trade policy remains a risk to the economic outlook. To date, the impact has been small, but will worsen as trade conflicts escalate. However, even in the worst case scenario, increased tariffs and retaliatory measures shouldn’t be enough, by themselves, to push the economy into a recession.”

“Fiscal stimulus (tax cuts and government spending) has been larger than expected. The federal budget deficit has deteriorated much more than anticipated in fiscal year 2018 and we’re now looking at a deficit of more than $1 trillion in fiscal year 2019. That means support for the economy in the short run, but a bigger problem in the long run.”

– Scott Brown, Ph.D., Chief Economist, Equity Research

“Key themes in my world include the upcoming election in November and trade wars. Anything that was in the bullseye of the Obama administration is now the darling of the Trump administration, and vice versa.”

“With the elections, I’m still of the belief that Republicans maintain their majority in the Senate and Democrats have enough seats to win the majority in the House. I don’t think that that’s a terrible thing from a market perspective.”

“Will we have impeachment hearings? Absolutely. Does the president get impeached? It's increasingly likely. But does he get removed from office? That’s extremely unlikely, unless there’s some other shoe to drop.”

– Ed Mills, Washington Policy Analyst, Equity Research

U.S. Equity

“With so many U.S. averages breaking out with new all-time highs, that’s not typically a sign of an unhealthy market. It’s not the same type of breadth we saw last year, but nobody expected it to be when last year was one of the greatest runs in market history.”

“Even investors who are believers in the bull market are still displaying negative sentiment and anticipation that we’re going to see volatility on the downside. Major concerns include elections, trade, and the seasonal September/October volatility.”

– Andrew Adams, CFA, CMT, Senior Research Associate, Equity Research

“There are three legs in a secular bull market. The second leg, which we are currently in, is always the longest and the strongest. It’s when earnings pick up and the economy starts to improve. Once it peaks, the markets will enter another upside consolidation. Finally, we’ll come out of that consolidation and start the third leg, or the speculative leg. That’s what bull markets look like.”

– Jeffrey Saut, Chief Investment Strategist, Equity Research

“We’ve been in the camp that the market is range bound. We’ve been saying that for months. We’ve probably been wrong in that position to a degree, and the main reason is because it’s been an absolutely perfect environment: very good earnings, and valuations have come down because earnings have outpaced stock prices. So everything checks the box there.”

“If you look at our base case of $168 in earnings in the S&P versus $172 for consensus, and apply our 18x multiple, we still see 5-6% upside for the S&P 500 over the next 12 months, so we still think that’s possible. However, we think that getting there could be choppy, especially in the next few months, so I remain a cautious bull.”

International Equity

“The view is that the midterm elections will give an opportunity for a more flexible trade policy for the U.S. administration, and therefore, neither top European nor top Chinese politicians are in any huge rush to strike a deal. Are both sides interested in doing a deal at some point? Absolutely. The Chinese crave stability, and they’ve got enough domestic changes coming that they need a stable environment to be okay. I see Europe taking the same position.”

“Trends I am seeing are low returns in Europe relative to the U.S. People have become very pessimistic. You can see it in fund manager surveys and fund flow data. Global investment managers have been selling Europe and buying America. People are focused on the influence of the strong dollar and the influence of trade disruptions. Still, there are opportunities in Europe and emerging markets.”

“In Europe, there’s been a lot of concern about lack of growth, immigration, political angst, etc. The good news about Europe is that France is still changing. Macron continues to do a pretty good job in France.”

“As for emerging markets, my feeling is that the positives remain in place. Aside from the big structural factors such as rising populations, the big positive remains that China is pursuing domestic reform. It doesn’t want to engage in a trade war and that’s why I think they are up for a deal, and they are up for opening their economy a bit. But they will absolutely wait until after the midterms to see the lay of the land.”

– Chris Bailey, European Strategist, Raymond James Euro Equities*

U.S. Fixed Income

“The big issue that I see is the leveraged loan market, which is now bigger than the subprime market. Everyone’s jumping into it. It’s a zero-duration yield, and I’m always skeptical when I hear those two terms in the same phrase, because we’re taking a credit risk, and I think that’s not quite as understood as it should be.”

“On the pure bond side, you can dial up duration, or dial down credit, neither one of which I care to do right now.”

“When we talk about the yield curve and the Fed, the one thing I see that is different is perhaps the motivation of the Fed. We went through seven plus years of zero interest rate policy. The motivation is to push rates to ʻneutralʼ levels to have some room to move in the future.”

“For the very short-term investor (inside two years), Treasuries have become a competitive alternative, especially for investors with high state income taxes.”

“As long as portfolios are heavily weighted with growth assets, you still need the diversification benefits of fixed income with some duration as a balance to riskier assets such as equities.”

– Doug Drabik, Senior Strategist, Fixed Income

Energy and Oil

“The steel tariffs out of Washington have increased component costs for pipeline projects and other energy infrastructure investment domestically. However, with oil prices near four-year highs, the increases are manageable for companies.”

“Oil industry investment in the U.S. is recovering from the commodity down cycle, but lagging behind the strength in oil prices and cash flows. This reflects the growing trend of capital discipline. Criticism from the investment community regarding their historical outspending has led many domestic oil producers to start returning cash to shareholders through dividends, buybacks, and debt reduction – versus plowing everything into growth.”

“The global oil market was undersupplied last year, it is undersupplied this year, and it will yet again be undersupplied in 2019. Supply increases in the U.S., Saudi Arabia, and Russia are being counteracted by geopolitically driven declines in Venezuela and Iran.”

*An affiliate of Raymond James & Associates and Raymond James Financial Services.

All expressions of opinion reflect the judgment of Raymond James & Associates, Inc., and are subject to change. There is no assurance any of the trends mentioned will continue or that any of the forecasts mentioned will occur. Economic and market conditions are subject to change. Investing involves risk including the possible loss of capital. International investing involves additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets. Past performance may not be indicative of future results. Asset allocation and diversification do not guarantee a profit nor protect against loss. Companies engaged in business related to a specific sector are subject to fierce competition and their products and services may be subject to rapid obsolescence. Changes in tax laws or regulations may occur at any time and could substantially impact your situation. You should discuss any tax or legal matters with the appropriate professional. The S&P 500 is an unmanaged index of 500 widely held stocks. It is not possible to invest directly in an index. Debt securities are subject to credit risk. A downgrade in an issuer’s credit rating or other adverse news about an issuer can reduce the market value of that issuer’s securities. When interest rates rise, the market value of these bonds will decline, and vice versa. Legislative and regulatory agendas are subject to change at the discretion of leadership or as dictated by events.

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